Make your company ripe for an acquisition by knowing what makes it an attractive buy.
First in a series on acquisition preparedness
Industry consolidation may mean good things to our industry for a number of reasons as discussed in the May issue of PPB (Consolidation: Will We Be Better Off?) but what does it mean to companies who want (or need) to sell? How do responsible owners of promotional products companies position their companies for sale in such a way that they achieve their personal goals and realize the maximum value for their companies? What do buyers look for in an acquisition?
These are questions for which every owner should have answers and a corresponding strategy. The questions also imply that owners should take different actions than they ordinarily would if they are planning to sell—but that’s not so. The vast majority of the actions should be taken whether a potential sale is imminent or not. That said, many company owners are not following through on all the necessary actions—and they should be.
What do buyers look for in a company they want to acquire? The answer is short and to the point. They are looking for evidence and assurance of continued future profit in the form of positive cash flow. While sales for the past decade may be impressive, they are not necessarily indicative of future profitability. There are a number of factors that contribute to the satisfaction of a potential buyer.
Accurate and Timely Monthly Financial Statements: Nothing kills the enthusiasm of buyers more than error-filled financial statements. How can a potential buyer possibly project future profit from bad historical statements? I know potential deals that have been terminated because the financial statements were junk.
Monthly financial statements are important because they help buyers understand seasonality. They also serve as the basis for trailing12-month financial results. If negotiations are taking place in June, buyers want to know what current trends look like for the past 12 months. Sales and profit may have been good for 2015, but what are current trends? Trailing 12-month financial results provide that information and an accountant can easily compute this. It is also important to finalize last month’s financial statements before the current month is over. We have had several clients who only run financial statements once per year. It takes others two to three months to complete monthly statements. Any delay in financial reporting puts transactions at risk.
Buyers will use the financial statements to analyze trends: sales, gross margin percentage, changes in individual expense levels, etc. Owners should be knowledgeable enough and prepared to answer these questions.
Buyers wonder if the owners don’t have the discipline to complete accurate and timely financial statements, what other shortfalls might there be in the operation?
Owner Involvement: How dependent is the company on the owner’s involvement. If a company can’t operate without the owner, that is a risk to future profits. Owners should transition their companies so they can operate substantially without them, lowering the risk to buyers.
Customer and Salesperson Diversification: Another risk to continued earnings that buyers evaluate is how much the company depends on the sales from individual customers or salespeople. Sales to one customer representing 10 percent or more of a company’s total sales raises the risk to the company should that customer be lost for whatever reason. The same principle applies to a salesperson with 20 percent or more of the sales, especially if the salespeople are independent contractors. Effort should be made to transition the customer relationships to company personnel through a customer retention strategy in order to reduce dependence on individual salespeople.
Salesperson Relationship: Continuity of salespeople from owners to buyers is a critical issue that buyers must become comfortable with. Several tools can help mitigate buyers’ concern:
• Employees or independent contractors. Employee salespeople tend to be more likely to remain engaged after an acquisition than independent contractors who are free to move on. The burden falls on buyers to influence whether independent contractors remain with the company after the sale.
• Contracts with customers help assure future sales.
• Non-compete Agreements. This topic always stimulates conversation about how “enforceable” such agreements might be. Each state is different and this article is not meant to be a legal analysis. However, without a doubt, it is better to have reasonable non-compete agreements than not. All employees should sign them on the date they begin employment whether they are salespeople or work in the office.
• Commission Policy. Commissions must be paid at a sensible level and consistent between all salespeople; no special deals. Buyers insist that all commissions are paid under the same terms and are reluctant to change excess commission rates for fear of alienating salespeople who have been spoiled by owners.
• Policy & Procedures Manual. Buyers want to be sure they understand how salespeople obtain and process orders, under what credit terms, from what suppliers, etc. Unfortunately, salespeople tend to function their way if no formal policies exist. That creates another potential future conflict between buyers and the sellers’ salespeople.
Business Plan: Many owners do not complete a business plan for their companies. However, to the extent that owners have a business plan and can demonstrate how the plan is working, it can build confidence in buyers that the employees and salespeople are focused on a plan that is working well.
The Next Steps
In addition to preparing the information buyers are looking for, there are a number of actions owners should take in the years before they plan to sell their companies.
1. Business Valuation: Owners often decide they want to sell their companies, but have no idea what they are worth. They probably have a portfolio on which they check the value daily and a house for which they have a pretty good idea of worth. However, their companies are probably their most valuable assets. A valuation with periodic updates provides a number of benefits:
• Benchmark for improvement in profitability and value
• Realistic expectations when negotiating a sale
• Estate planning
2. Tax Planning: Owners should work with financial advisors to develop a plan to minimize the tax consequences of selling their companies. For instance, C-Corps have substantial negative tax consequences when they are sold. They should be converted to S-Corps as soon as possible because there is a waiting period to realize the tax savings of an S-Corp.
3. Succession Plan: In order to maximize the ultimate value of their companies, owners should develop succession plans that identify the time and circumstances that will trigger their efforts to sell their companies. A plan doesn’t have to be carved into stone, but should be thoughtfully prepared. Otherwise the disposition of companies is determined by outside circumstances, health or financial issues. Excellent opportunities will be lost or overlooked.
As you can see, none of the actions in this article are difficult or onerous. They all have benefits to owners and their companies irrespective of whether they are sold. They do require effort and discipline to implement, but once done, they will not be difficult to maintain and will result in the maximization of value if and when owners decide to sell.
Jeffry Meyer, MAS, CPA, is CEO of Huntertown, Indiana-based Certified Marketing Consultants, Ltd., a PPAI business services member. He has been active in the promotional products industry for more than 35 years. He and his two partners serve companies exclusively in the promotional products industry with services including mergers and acquisitions, business valuations, strategic planning, business plans, marketing plans and general consulting.
Six Things That Don’t Help Sell A Company
1. New investments that will take time to increase profit and cash flow. Buyers won’t pay for unproven future benefits.
2. Long-term leases. Buyers base the value of an acquisition partially on reductions in expenses that they can implement, like facility costs. Long-term leases can tie their hands, reducing the amount they will offer for a company.
3. Excess commissions. If commissions paid are in excess of industry standards, buyers will balk at buying such companies because the rates are not sustainable.
4. Owners paying themselves less than what their efforts are worth. By all means, owners should pay themselves at least market value. Buyers are not going to be fooled into thinking the company is more profitable if owners don’t pay themselves appropriately.
5. Reducing expenses below sustainable levels, especially sales and marketing expenses. This may result in short-term increased profit, but buyers will sniff out this strategy in a heartbeat and instead become concerned that future sales will suffer from lack of marketing.
6. Minority Ownership Certification. Certifications can be valuable door openers, but if substantial revenue is dependent upon certifications, it will require that a buyer has that certification. This creates a very restricted buyer list.
Four Things That Don’t Add Value To A Potential Sale
1. The owners’ tenure in the industry. This can actually be an indictment of owners whose companies aren’t prospering despite “30 years in the industry.”
2. Higher sales levels two or three years ago. Only sales in the past year/12 months are relevant. This is one reason a succession plan is important; to sell when revenues are up, not two years later.
3. Investments the buyer will make. “If a buyer provides capital, the company will grow substantially.” That may be true, but buyers are not going to pay value to sellers for positive results that buyers expect to realize from their efforts and capital.
4. Intellectual properties, customer industry niche, industry awards, proprietary products and services. Such qualities may increase the confidence buyers have in investments, but their actual value is determined by the companies’ sales and profit performance.